Lessons Learned From SPIVA

There is nothing novel about the index versus active debate. It has been around for decades, and there are a few strong believers on both sides, with the vast majority of investors falling somewhere in between. 2012 is the 10th anniversary of the widely followed SPIVA (S&P Index Versus Active) Scorecard, and over the past decade of serving as the de facto scorekeeper of the active versus passive debate, I have heard passionate arguments from believers in both camps when the headline numbers do not turn out to conform with their beliefs. But beyond the headline numbers of SPIVA is a rich data set addressing issues of measurement techniques, universe composition and fund survivorship that are far less discussed, but which I have always found more fascinating. In the spirit of celebrating 10 years of SPIVA, this article is a reminiscence of 10 things I have learned.

1. Indexing Almost Always Works Over A Five-Year Horizon Short-term results, such as those over 12 months or even three years, often swing between favoring indexes or active funds. There is no consistent way to divine in advance whether the subsequent year would favor passive or active. But there is remarkable consistency over five-year periods. Every SPIVA report shows that during a five-year market cycle, a majority of active funds in most categories fail to outperform indexes. Therefore, if an investing horizon is five years or longer, a passive approach may be preferable. (See Figure 1.)

2. Bear Markets Do Not Necessarily Favor Active Investing Bears markets should favor active managers. Instead of being 100 percent invested in a market that is turning south, active managers have the opportunity to move to cash, or seek more defensive positions. Unfortunately, that opportunity does not translate to reality. In the two bear markets we have seen over the last decade, most active managers failed to beat benchmarks. (See Figure 2.)

3. Consistency In Performance Exists . . . But In The Wrong Quartile The SPIVA Scorecard presents results on average for the fund industry, and in the years following its launch, some investment gatekeepers told us that it is not necessarily relevant since they do not put their clients' money in an "average" fund. When a decision has been made to invest actively, these gatekeepers go through a screening process that typically screens the universe for top-quartile or top-half funds, and then narrows down to the final choice by researching factors like investment philosophy, fees, downside risk, Sharpe ratio, etc. This was a valid argument, and we created the S&P Persistence Scorecard as a companion to SPIVA in 2005 to evaluate the consistency of performance of active managers. Since then, every single report we have published shows that the chances of finding a top-quartile fund for the future by using historical top-quartile performance is similar or less than random expectations. There is consistency in performance—but in the wrong quartile. Funds that have delivered bottom-quartile performance in the previous three or five years have a consistently high chance of being merged or liquidated. Clearly, asset management companies go through a regular spring cleaning process to make their slate of funds look good. The Persistence Scorecard points investors in an interesting direction: Instead of screening for top-quartile funds, you may be better off screening out bottom-quartile funds. (See Figures 3a and 3b.)